We are increasing State Bank of India’s, or SBI’s, fair value estimate by 13% to Rs 315 per share, or $50.80 per GDR, as we reduce our cost of equity, or discount rate, to 12% from 13%. Our fair value estimate represents 1.4 times 2016 book value per share, and 14 times our fiscal 2016 earnings per share estimate. The lower cost of equity assumption is in line with a global change to Morningstar’s cost of capital methodology as it takes into account a lower required investment return for the U.S. market of 9% versus 10% previously, for companies with average systematic risk. To this return we add a 3% country premium for India, to reach a 12% cost of equity for an Indian company with average systematic risk. Since SBI’s performance is closely linked to the Indian economy, we consider the stock as having average systematic risk.
We are also take down SBI's fair value uncertainty rating to high from very high. SBI has managed to maintain a relatively good loan loss profile in the midst of slowing economic growth despite having a bulky loan book.
Our narrow economic moat rating remains unchanged, as we believe it continues to have significant cost advantages given its strong liability franchise which allows it to fund its balance sheet through a large pool of low-cost deposits.
These changes aside, our financial forecasts and outlook for SBI remain unchanged. Our five-year average earnings forecast remains at 16% supported by strong loan growth of 12% over our explicit forecast, and deposits growing at 11% on average. Overall, we maintain our favorable outlook, and believe the shares are reasonably valued trading at a modest discount to our new, higher intrinsic valuation.
